Doing Deals In China: A Legal Perspective

Wang: We have three offices that serve China and greater Asia. In 2004, I helped to open our first office in Shanghai and that's where I am located now. In 2007, we opened an office in Hong Kong. In 2008, the year of the Summer Olympics as well as the beginning of the financial crisis, we opened a Beijing office. Collectively the three offices serve China and greater Asia.

Wang: My primary role is working on cross-border merger and acquisition (M&A) and private equity transactions. Generally, they are inbound transactions representing foreign private equity sponsors and venture capital funds. In China on the private equity side, our transactions tend to be of the growth investments type, which typically are minority stake rather than majority stake deals. However, we have done some control deals as well.

On the strategic side, the cross-border M&A side and the joint venture side, we represent various multinational companies in connection with their M&A activities in China, either on the buy side or the sell side. More recently, we have also been doing some outbound deals for Chinese companies looking to make strategic acquisitions abroad. Increasingly, Chinese companies are doing cross-border deals and implementing their business plans by doing M&A deals outside of China.

While some recent higher-profile outbound deals tend to be natural resource plays, whether in Australia, Africa, Canada or some of the former Soviet Republics, we are seeing increased M&A deal activity involving U.S. and European targets. However, the outbound M&A deal process can be more cumbersome because of the regulatory approvals on both sides. For Chinese companies to do outbound acquisitions, they have to go through their own regulatory approval process within China before they can do the deals with U.S. companies, and depending on the industry, there will be potential U.S. regulatory review and approvals as well.

Still, the U.S. market is one that is appealing to Chinese buyers, but one that is still taking some time to develop. There are a lot of cash-rich Chinese buyers, so I think it's just a matter of time. The question is how soon. So, the majority of our deals have been inbound deals, but increasingly we are looking at outbound deals as well, and I believe more will happen in the future.

Editor: What's the trend in China regarding the extent to which Chinese regulators are involved in transactions? How difficult is the regulatory process?

Wang: Regulatory approvals are still required. However, there has been a relaxation in the review and approval process in the last few years. In fact, many approvals that would have occurred at the central level in Beijing have been delegated to the provincial level based on deal size. That has been a plus for the process, because going to Beijing invariably meant more red tape.

At the same time, another issue with the regulatory process is that although the level of sophistication of regulators has continued to improve, whether at the central, provincial or local level, there is still a learning curve as the relevant authorities continue to gain a better understanding of complex deal terms during the review process.

Editor: Statutes like the U.S. Foreign Corrupt Practices Act (FCPA) are becoming more common in other countries. Is there a similar concern about corruption in China?

Wang: The FCPAis clearly a big issue for U.S. companies doing business in China, especially with the DOJ's heightened enforcement. For U.S. companies with investments in China involving Chinese partners or staff in China, due diligence with regard to FCPA compliance is particularly important because the U.S. company can be held accountable for their actions.

In China, like any other developing nation, there are always potential bribery and corruption issues. At the same time, the Chinese government recognizes the problem, and they have every incentive to enforce their Chinese bribery laws. That enforcement tends to be selective at times, but there is no question that from the government's own perspective, it's in China's interest to ensure the legitimacy of its own government by cracking down on bribery and corruption. Therefore, due diligence by U.S. companies is also important to avoid the sometimes extreme penalties exacted by Chinese law as well as to avoid FCPA violations.

Editor: What about Hart-Scott-Rodino (HSR)?

Wang: Actually, the issue here is not so much HSR but rather the new Chinese anti-monopoly law (AML). In 2008, the AML came into effect, which requires filings to be done in China for global acquisitions where a significant China component is involved and the applicable thresholds are met. The scope of the AML has become a more important issue for foreign companies doing global M&A deals. In addition, the authorities are continuing to adopt additional rules and regulations to further interpret the law itself, so this area of law will continue to require careful monitoring as it further develops in China.

Editor: What has been the effect of the new Chinese labor law?

Wang: The new labor law that came into effect a few years ago was viewed by many to be more pro-employee, which is not surprising. China, being a socialist state, tends more to follow the European model rather than that of the U.S. As a general matter, whether because of the law or otherwise, China labor issues have caused concerns for some foreign investors because of their effects on the cost of doing business. Historically, China has been the low-cost manufacturing alternative for many foreign companies. In this regard, in some ways, the new labor law has helped to change that picture for some companies given some of the increased costs associated therewith. While China is still clearly much cheaper than most western countries, some of the competing countries in Southeast Asia, for example, have benefited from the Chinese labor cost increases that have resulted in part from the new labor law.

Editor: Are there situations when a foreign investor has engaged in a business in China but in a fairly short period discovered that their joint venture partner has become dominant and that they were frozen out?

Wang: Finding a JV partner that you can trust is always an issue. Although JVs do provide a very viable investment alternative in China, you have to come in with your eyes wide open. A key component is a governance strategy and a governance framework that ensures the Western partner has either full control or shared control. But, there is no question that with joint ventures, just like any marriage, you have to find the right partner. If you don't, things can get messy.

Editor: Previously, foreign investors were channeled into joint ventures. Is it possible in China now to have 100 percent foreign ownership?

Wang: Yes, there are someindustries that aren't as restricted, where the way to go to maintain control is to come in through your own subsidiary. In those industries, foreign investors are permitted to establish what is known in China as a "wholly foreign-owned enterprise," or WFOE for short.

Editor: Tell us about the restrictions on the use of intellectual property contributed by a foreign joint venture partner.

Wang: The issue of the contribution of IP in China is complicated. When you think about a JV and its capital contributions, whether in cash or non-cash assets, one of those non-cash assets could be in the form of intellectual property rights. From a Chinese law perspective, such intellectual property rights should be owned by the JV as opposed to being licensed. So that is always an issue. How do you show you're committed to your JV partner without necessarily giving up your crown jewels or risking problems with respect to your IP?

This is an area that continues to be a conundrum for foreign parties. Ideally the most appropriate way to protect your IP would be not to contribute the IP to the JV. In the alternative, you might contribute cash and/or find ways to license the IP instead of assigning your interest in it. For a host of reasons this is always a hotly negotiated issue.

Editor: Is there any problem getting capital out of China?

Wang: That remains an issue. China's RMB currency still is restricted currency. Typically, you can pay a dividend once a year at the end of the year out of your legally viable net profits subject to certain restrictions. So, dividend payments are one of the primary ways of repatriating funds out of China.

Editor: Have advances been made in the protection provided to American companies against infringement of intellectual property rights?

Wang: There is no question that on the books, the laws are there for enforcement. It's a matter of proper enforcement, but in China proper enforcement can be an issue. Yet, as China tries to climb the value chain, it realizes the importance of the protection of IP rights. At the same time, we know that there are local operations in China that continue to sell pirated software and counterfeit handbags and DVDs, and some local authorities may not necessarily want to put them out of business. So it's a tension for them. Still, there is no question that the enforcement of IP on behalf of multinationals is an area that the Chinese authorities are taking more seriously such that the enforcement environment is improving.

Editor: What is the situation with respect to dispute resolution?

Wang: To the extent possible , dispute resolution for a foreign company is usually done through arbitration. Arbitration in a neutral forum is the ideal choice. Most foreign investors are not as comfortable with Chinese courts for various reasons, such as concerns regarding local protectionism, perceived lack of sophistication of the court system or other similar reasons. Separately, I would note that judgments from U.S. courts cannot be enforced in China. Therefore, since China is a party to the New York Convention on arbitration, and as such Chinese courts are required to enforce foreign arbitral awards, foreign parties will typically seek to include mandatory arbitration provisions in their contracts.

A primary issue is the venue for the ADR process. In my experience, Hong Kong is often preferred because it has a sophisticated legal system yet it's also a part of China. Thus, while it's considered more neutral as it is outside of the mainland, because it's still technically part of China, albeit as a special administrative region, it is generally viewed as a more acceptable arbitration venue for both foreign and local parties as compared to other foreign jurisdictions.